Income Investing: Diversify with Global Fixed Income

In the current low-yield environment, retirees seeking high-yield investments might be better served thinking about a total return approach rather than current income.

"Investments that pay high yields do so because they are deemed to be riskier," says Peter Lazaroff, the chief investment officer at Plancorp and BrightPlan.

In today's low-yield environment, Lazaroff says, investments paying enough income to live off of are likely to be substantially riskier than what makes sense for a retiree. "A better approach today would be to embrace a total return approach that lets you live off your portfolio's income and price appreciation," he says. "The key to doing this well is being highly diversified in both your stock and bond allocation."

Lazaroff's favorite diversifier is global fixed income. "Since yields across countries do not move in lockstep, global bonds afford investors an unusually impactful way to reduce volatility in their fixed income portfolios," he says.

One fund that Lazaroff is particularly fond of is DFA Five-Year Global Fixed Income (DFGBX), which, he says, "provides diversified global bond exposure, but it is also attractive because it applies a variable maturity strategy that essentially like value investing with bonds."

For example, if investors are getting better compensated for taking duration risk because the yield curve is sloped upwards, it will invest more heavily in longer-term bonds, Lazaroff notes.

"The opposite applies to a flat yield curve, which would result in greater investment in shorter-term bonds," he says.

The other attractive feature of this fund, says Lazaroff, is that it uses market prices and yields to determine the implied credit risk rather than relying on the credit agency scores, which are notoriously delayed and reactionary.

This fund isn't available directly to retail investors, but it is available through financial advisers or an online fiduciary adviser such as BrightPlan, where -- in the interest of full and fair disclosure -- Lazaroff is employed.

Others also say investors who reach for yield are asking for trouble.

"Interest rates are extraordinarily low everywhere," says Chris Cannon, the chief investment officer at FirsTrust. "My interactions with investors strongly suggests the resulting 'reach for yield' has far too many people, especially retirees, taking far more risk than they understand."

To be fair, Cannon says investors ought to spend time learning more about income and the concepts associated with income before investing their money.

In meeting with clients and prospects, Cannon says he tries to explain "income" from a tax perspective and from the perspective of the source of the instrument producing the "income" (interest vs. dividend vs. capital gains).

He even tries to explain the capital structure of corporations in terms of risk to the owners of securities, given the seniority of payments and credit worthiness. And then he explains how fears of spending one's "principal" can also push people into investments they again don't understand because they're overly focused on avoiding eating into principal.

"From my experience and perspective, this is the bigger question that should be addressed for most investors," he says, and not necessarily what sort of investments might retirees who are seeking current income in this market consider.

All that said, he suggests looking for opportunity among midstream energy companies and select utility companies at the moment. "I again want to stress how the risks associated with these kinds of investments are very real, especially if the audience is retirees expecting the safety and security offered by CDs or other principal-protected instruments," he says.